Three years ago next month, a long-time Twin Cities CEO joined about 20 other Minnesota business leaders to meet privately with Gov. Mark Dayton in downtown Minneapolis. The governor talked about the state’s business climate and his priorities, and then the format opened up into a Q&A session.

It was just as the governor and Legislature were forming significant tax increases for wealthier Minnesotans. And it followed intensified auditing of individuals accused of skirting state residency laws, based on a list of 26 factors used to determine whether the individual owed Minnesota taxes. (See “Fueling the Migration” box below.)

Fueling the Migration

Two actions and one inaction by the Minnesota Legislature in 2013 led to the “last straw” for many wealthier Minnesotans.

That year, Gov. Mark Dayton and the DFL House and Senate majorities enacted a tax bill increasing by 25% the taxes to be paid by the state’s highest wage earners—and lowered the threshold of “highest” to individuals making $154,950 or more annually or households making $258,260 or more annually.

The new top rate of 9.85% ranks as the third-highest such tax in the nation. It also hit many of the state’s 22,000 Subchapter S corporations, as their profits are passed through to their owners’ tax returns. In comparison, Florida has no income tax (nor do South Dakota, Texas, Nevada and three other states). Florida also has no tax on pension or Social Security benefits.

The second action was the enactment of a gift tax, one of only two such state gift taxes in the country. The tax was on the transfer of property by one individual to another while receiving nothing or less than full value in return. It was 10% on such gifts in excess of a lifetime total of $1 million made by Minnesota residents—and non-residents who owned property in Minnesota. There was such an uproar the Legislature repealed the gift tax a year later.

The inaction in 2013 pertains to the estate tax. That year, Congress approved an exemption amount of $5 million, indexed to inflation (so in 2016 it is $5.45 million per individual or $10.9 million for a married couple) on federal estate taxes. If the estate is below this level when the individual dies, heirs pay zero estate tax. If it’s over this amount, the estate can be taxed up to 40%.

Minnesota is one of 14 states that still have an estate tax (which dates from a time when the federal estate tax allowed a dollar-for-dollar credit for state estate taxes; this ended in 2001, and the majority of states repealed their estate taxes). Unlike the federal estate tax, Minnesota’s kicks in at more than $1 million in estate value (this will rise to $2 million by 2018) and is taxable at between 9% and 16%—on top of what’s paid in federal estate taxes.

These actions and inaction followed years of intensified auditing by the Department of Revenue of those who claim their domicile is in another state but still have a home here and visit often.

The department appears to be trying to soften its image, however. Three months into her job last March, Revenue Commissioner Cynthia Bauerly issued a 2015 Residency Report based on listening sessions held with various constituents. As a result of those sessions, she says, “The department is making several changes to our processes for addressing domicile and residency.” They include simplifying its request for information, reducing the amount of information initially requested, doing a better job of answering taxpayer questions and training employees.

The department also has reduced the number of audits it conducts each year, from 180 in 2013 to 149 in 2015. —D.K.

“I brought up that people are leaving—people who have a fair bit of assets and the ability and wherewithal to leave—and what worries me is that when they do, they’re not going to come back because they learn they can live in really nice places and not pay our state income tax,” says the CEO, who heads a near-century old business with 600 employees and $200 million in annual revenue. “His response was, ‘Well, people are free to live wherever they want to.’ So his answer was he doesn’t care if they leave.”

The CEO moved to Naples, Fla., while keeping his company’s headquarters—and its 250 employees—in the Twin Cities. He says he would have stayed had he felt more welcome. “It’s one of those things I said to Mark: ‘If you can just make it a little more fair for entrepreneurs and business owners, many of us would say, “That’s OK, I can deal with it.” But it doesn’t seem like you want to keep us here.’ Minnesota now has an anti-success feeling.”

In January, this same individual ran into Florida Gov. Rick Scott while attending a dinner. “I said hello, introduced myself and my wife, and said, ‘We are among your newest residents,’ ” he recalls. “He said, ‘Welcome to Florida,’ adding, ‘You know, I really need to send your governor a thank-you note for all the people moving from Minnesota to Florida.’ And at the end of our conversation, he added, ‘If there’s anything I can ever do for you, please let me know.’ I was in complete shock.”

While anecdotal, the CEO’s thoughts are similar to those expressed by more than a dozen other successful business owners and leaders contacted for this story. Several say it was a one-two punch that is pushing them out: increased taxes and a sense that state government has turned anti-success/anti-wealth. So much so that almost none of them, including the CEO just described, are willing to be identified when talking about this issue with the media for fear of being audited.

Such a perception—and its potential impact on a state’s economy—can be like cancer: It’s often discovered too late, unless there are regular check-ups. This magazine’s examination finds Minnesota may indeed take an economic and cultural hit due to a souring sentiment among its wealthier citizens, thousands of whom are now moving billions of dollars in annual taxable income, gross estate value and net worth to other, more welcoming states.

Billions leaving

During the last two years, Minnesota lost or began losing an estimated $2.1 billion in taxable income from 3,099 taxpayers, according to a research study on wealth migration conducted by Twin Cities Business with help from research firm The Morris Leatherman Company (see “The Research” at the bottom of this page). These same individuals have $17 billion in median net worth and $31 billion in median gross estate value.

In almost three-quarters of those moves, respondents said the reason for leaving had to do with Minnesota’s tax policy and collection practices. This amounts to an estimated loss of approximately $1.5 billion in annual taxable income, $12 billion in average net worth and $22 billion in gross estate value due to Minnesota’s tax and collection activities.

The TCB study also found this trend will continue for at least the next five years, during which time an estimated 12,172 Minnesotans will leave, taking with them a combined $5.2 billion in taxable income, $65 billion in net worth and $122 billion in gross estate value.

TCB’s estimates on wealth migration are conservative—median numbers rather than averages. And they represent feedback from 150 money management, legal, accounting, banking, financial advisory and financial services firms during a six-week period ending Feb. 26. There are hundreds more such firms; reaching more of them likely would have increased these estimates and in no way would have lowered them.

“These findings are meaningful given Minnesota’s policy course has been heavily influenced by what happens to net tax revenue” says Mark Haveman, executive director of the Minnesota Center for Fiscal Excellence. His organization provides analysis, consultation and legislative testimony on issues of tax policy and public finance.

“The thinking has been it’s acceptable to lose some high-net-worth individuals because the loss of tax revenue from those who do leave will be more than offset from revenue gained by those who stay. These results suggest that whole premise needs to be reconsidered,” he says.

“There’s a quality of life issue at issue here too. These households contribute more to the state than just tax dollars,” Haveman adds. “Philanthropy, volunteerism, professional networks and relationships—this is also part of our fabric and a key to our success. We seem to be making a very big bet on Minnesota’s irresistibility as a place to live.”

Impact on state revenues

How Minnesota Ranks

• Florida has no income tax (and neither do Texas, Nevada and four other states). Florida also has no tax on pension or Social Security benefits.
• Our state and local income tax collections per person were the sixth highest nationally (Tax Foundation, 2011 data)—before taxes were increased in 2013.
• The state’s corporate income tax system consists of a flat rate of 9.8% and is the third highest (Tax Foundation, 2011 data) among states levying a corporate income tax.
• Minnesota has the fourth-highest capital gains tax rate, tied with Oregon at 9.9%.
• Minnesota is one of only a handful of states that still collect an estate tax. It applies to life insurance proceeds, real estate, 401(k)s, investments and more. And it’s a leading reason people move: The 14 states that had an estate tax in 2013 had $92.7 billion in net outflows of adjusted gross income from 2000 through 2010, according to the Fiscal Times.

While TCB’s study only looked at how much wealth was leaving Minnesota, other sources indicate the state is losing more wealth than it is gaining each year and that this loss has spiked since 2013, when the state raised taxes on its wealthier citizens.

Research from the Minnesota demographer’s office shows that between 2008 and 2012, 22,166 higher-income non-student individuals moved into the state. More left during the period, however, for a net loss of 1,913 higher-income individuals. This was before the changes mentioned above in tax policy and practices took effect.

Since then, the annual net loss of higher-income families in Minnesota has apparently surged, according to Minneapolis conservative think tank Center for the American Experiment’s March 10 report on recent IRS data.

On a net inflow/outflow basis, Minnesota lost between $240 million and $490 million in annual taxable income each year between 1997 and 2012, according to the report. In 2013 this rose to $697 million, and in 2014—the first full year in which the recent tax changes were in effect—it shot up to nearly $1 billion.

Findings from TCB’s study indicate the annual taxable income flowing out of Minnesota was likely even higher in 2015, and it’s expected to continue for years to come. Areas where it will likely have an effect include state tax revenue, charitable giving and financing for early-stage businesses.

Based on their annual taxable incomes, the 13,000 individuals TCB estimates left or are in the process of leaving the state represent approximately half of Minnesota’s top-tier tax population of 25,806 households as described in the 2015 Minnesota Tax Incidence Study. These households provided the state with 26 percent of its total individual income tax revenues in 2012.

The Minnesota Department of Revenue believes this top tier’s taxable income will grow by nearly $9 billion by 2017 and, at that time, generate 28 percent of Minnesota’s total individual income tax revenue, according to the incidence study.

TCB’s findings show the opposite is more likely to occur, given approximately $6 billion in Tier One taxable income just moved or plans to move out by 2020. There will likely be some Tier One taxable income moving into the state during this time, but it would take nearly $15 billion in such inflow to offset the exodus that’s occurring. And the state demographer’s and Center for the American Experiment’s trend data provide reasons why this likely won’t occur.

Too risky to give

To Stay or Not to Stay

There are several reasons people move to another state. TCB’s study on wealth migration surveying money management, legal, accounting, banking, financial advisory and financial services firms asked 16 questions about their clients’ plans to stay in Minnesota and whether they plan to leave and why. It also asked firms to indicate if any of their clients moved or began to move during the last two years and why they moved.

Reasons to stay or move ranged from culture, society and community, family/friends, climate/recreational opportunities and job/career opportunities to state personal income tax, state estate tax and state tax collection activities directed at people living here part of the year.

Some 65% of clients planned to stay in Minnesota beyond five years. Fifty percent of firms surveyed say this is down from 2010; 34% of those say it was down by more than 20%. The reasons clients most frequently cite for staying were to remain close to family/friends, culture, society and community, job/career opportunities and medical/health reasons.

Firms indicated that of the 35% of clients who plan to move within the next five years, the top three reasons were Minnesota’s personal income tax, the state estate tax and the state’s tax collection activities. Climate/recreational opportunities came in fourth. —D.K.

While the Department of Revenue states that it does not consider where one donates as one of its 26 factors in weighing whether an individual owes Minnesota taxes, wealthier residents, when deciding to move to another state, are more frequently opting to sever all ties here, including charitable giving.

“The folks who do change residency are changing residency. They’re not just dipping their toe in the water, they’re going to make sure it’s solid, and this includes severing charitable giving,” says an accountant who asked for anonymity because his firm does some work paid for by the State of Minnesota.

“We’ve been seeing it for a few years now, with folks not wanting to take the risk of contributing to Minnesota charities. Anecdotally, we hear many of our donors may have a wedding to attend or something else in this area, and while Minneapolis/St. Paul may be the easiest airport to fly into, they won’t do it, as they don’t want to risk having a pause on Minnesota soil,” says Kittie Fahey, vice president of major gifts at the Greater Twin Cities United Way. The thinking is that every hour adds up, though the Department of Revenue says it doesn’t start counting time through Minnesota airports until after it totals more than 24 hours per occurrence.

About 15 percent of top donors—a tier that traditionally contributes 40 percent of the Twin Cities United Way’s funding each year—have severed ties with the charity in a quest not to be bound by Minnesota taxes or be audited by the Department of Revenue, says the organization. Even when Minnesota audits find nothing, they can run several thousand dollars in accounting and legal costs.

“It started about six to eight years ago, reducing to half their funding still coming to Minnesota and the other half going where they now live,” Fahey says. “But beginning in 2014, they began to go with no gifting whatsoever.”

Her organization has offset those refusals by more heavily cultivating its pipeline of donors and offering more diversified investment opportunities. As a result, overall fundraising from the top 1 percent has not dropped.

Fahey says United Way tells donors the state says it does not consider charitable contributions as a factor in residency. “These are people who are really committed to giving here. But they have been advised by their tax advisors and their friends to not take the chance.”

They cite tales of aggressive audits; legislative actions such as the 2013 gift tax; and legislative proposals such as the governor’s attempt in 2013 to enact a “snowbird tax,” expanding the number of people required to pay Minnesota income taxes.

It’s a similar story elsewhere. “I can’t cite cases where they have been audited, but some investors have told me, ‘I don’t want to invest in any charity or university in Minnesota anymore because it will look like I have a tie there,’ ” says Lou Nanne, chairman of fundraising for athletic facilities at the U. “I try to alleviate their concerns, but they say, ‘No, we’re not going to put ourselves in that position.’ ”

Nanne says he started hearing from donors and prospects after the state passed a gift tax and did nothing to alleviate, or eliminate, its low-threshold ($1 million) estate tax in 2013. “They have a big concern here,” Nanne explains. “They don’t want to be tied to the state because it can affect their estate taxes.”

Other nonprofits and their board chairs cite concerns about their fundraising base.

“We’re hearing from people that, while where they donate is not a factor, . . . [the governor and Legislature] could change their mind,” says Jeremy Wells, vice president of philanthropic services for Minnesota Philanthropy Partners. “Several of my donors have started funding the Collier Community Foundation [in Naples, Fla.]. They haven’t stopped giving here, but they’re starting to think about it.”

Funding the future

In addition to supporting the arts, wealthier Minnesotans have a long tradition of backing startups. The state’s economy—particularly over the last 70 years—has been buffered by investments and reinvestments in startups ranging from the Breathe Right Nasal Strip, Sleep Number Bed and Life Time Fitness to Pentair, Medtronic and UnitedHealth Group.

Given this, the $122 billion in gross estate value estimated to be leaving Minnesota within the next five years may have the greatest long-term impact on the state.

“As somebody with a family here in Minnesota, I’m very disappointed to see the capital drain,” says the accountant who asked for anonymity. “The capital that helped build 3M, Medtronic and other Minnesota companies is now going to support businesses in Florida, Texas, Nevada, Arizona—where the capital is going. Once it goes, it never comes back. So our tax base will erode with time.”

But this, too, is something that is not measurable today and will take years to assess.

Possible solutions

Other states have grappled with net outflow of wealth in recent years, and a few have found ways to reverse the trend—or at least stop the bleeding.

A Sample of Exiting Wealth

A second Twin Cities Business study was conducted among 17 individuals who recently moved (2013-2015) or plan to move from Minnesota and who cite its tax laws, policies and collection efforts as the primary reason. They take with them $24.7 million to $72.4 million in taxable income and $601 million to $875 million in net worth.

Most provided personal notes about the state’s policies and procedures, which some say vilifies the successful. Several said they know of others who have recently moved or are planning to move for the same reasons.

For every one of those high-income/net worth individuals who leave, Minnesota loses $1.5 million to $4.3 million in taxable income and $35 million to $51.5 million in overall net worth. —D.K.

“Taxes are one of many reasons why people move, and they’re important ones that policy makers have control over and can do something about,” says Scott Drenkard, director of state projects at the Tax Foundation in Washington, D.C. “Whereas it’s hard if not impossible to change other reasons—such as education, which can take decades to improve, or the weather.” Drenkard co-authors the foundation’s annual State Business Tax Climate Index.

North Carolina completed a significant tax overhaul in 2013. “My prediction is Charlotte, given it’s an investment hub with legacy banks located there, might turn out as a real viable alternative to New York City for people looking to expand or open offices in the financial sector, because taxes are now so much more favorable there than in New York,” he says. Another state that has been working on changing its tax situation is Indiana, which in 2011 determined it was perceived as uncompetitive because of high corporate income taxes.

“They started a multi-year process of phasing down the [corporate flat] rate from 8.5 percent to 6.5 percent today, and 4.9 percent by 2021. The individual [flat] rate also has been decreasing, though less dramatically, and is now at 3.3 percent,” he says. The changes led to Indiana moving from 44th to 16th in one year in terms of states with the best corporate tax environment. Minnesota ranks 47.

While one might think such rate reductions would reduce tax revenues, Indiana has seen an increase, Drenkard notes. “It’s been successful in how it cut taxes, and it benefited from riding the [national] economic growth that has happened since 2011. They also slowed the growth of government spending.”

Other states that have lowered certain taxes in recent years in an effort to retain—and attract—more upper-tier taxpayers and businesses include Tennessee and Ohio.

Asked about TCB’s findings, Revenue Commissioner Cynthia Bauerly says she’s listening and balances the input of wealtheir taxpayers with what she hears from other tax-tier payers. “What I take away from those conversations is that people make decisions in their lives for a lot of different reasons and for other things such as whether they are connected in their communities or where their families are.”

She adds that they also consider where it’s good to grow a business with a well-trained workforce and good roads allowing people to easily get to and from work. “The state has a good reputation for investing in these things. There’s a reason why CNBC ranks us as No. 1,” Bauerly says of Minnesota’s ranking on the TV channel’s annual list of America’s Top States for Business last June.

In its announcement, CNBC said, “Minnesota shows that there are multiple paths states can follow to be competitive. The state took a gamble by raising taxes in 2013, and at least so far it has paid off in improved state finances, and the fact that businesses were willing to stay put in order to take advantage of the state’s excellent workforce, top-notch education system, and superb quality of life.”

The most important words in that statement may very well be “so far.”

The Research

Here’s a snapshot of the research study conducted for this story. Further details are available upon request.

Analysis

• Median 350 clients per respondent
• Median 72 percent of clients reside in Minnesota = 252 Minnesota clients per respondent
• 82% (123) of respondents indicated some of their Minnesota clients changed or began changing their residency within the last two years
• Average of 10% of clients changed or began to change residency within the last two years
• 10% of 123 firms with a median of 252 Minnesota clients equals 3,099 clients
• Median gross estate value of clients who changed or began changing their residency within the last two years is $10 million
• The median taxable income of clients who changed or began changing their residency within the last two years is $677,000
• The median net worth of clients is $5.4 million
• 72%, or 2,231 of these clients, moved or are moving due to taxes or policies

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